What are the prospects for employee ownership in the future? In the last issue
of Owners at Work, we began a series on the future of employee ownership. Articles
by Corey Rosen and by Norm Kurland and Dawn Brohawn respectively looked at employee
ownership in the United States and the role of Kelsonian economics in the future.
In this issue, Michael Keeling provides a very provocative look at the legislative
prospects for employee ownership in the United States. Given the fact that Keeling,
the President of the ESOP Association, is undoubtedly the most knowledgeable
person in the country on ESOP legislation, there's reason to take notice when
he visualizes an ESOP world in which taxes play a much less important role.
The second article, by Karen Thomas, began as a discussion of the large employee-owned
sector in Spain in the Basque region of Mondragon. The Mondragon group of cooperatives
is the largest group of employee-owned companies in the world. Thomas's themes
turned her article into a piece that dealt as much with the future as the present.
First, Thomas focuses on the difficulties of adapting a very community-oriented
economic model to meet the challenges of global competition. Second, Thomas
speculates on Mondragon's lessons for Ohio.
Read on to find out where we may be going on Capitol Hill and in Europe. Let us know whether there should be a Mondragon experience in Ohio's future.
The Legislative
Future of Employee Ownership
J. Michael Keeling
With the understanding one has to be somewhat crazy to make predictions that
cover a one hundred year period, doing so can be fun and thought provoking.
Also intriguing is the fact that many of today's employee owners in their 20's
and 30's, will be alive as the 21st Century winds down, and will probably have
played a major role in the development of employee ownership during the period
of 2020 to 2050.
Here is a primary prediction that is not about employee ownership per se, but
which will have an enormous impact on current laws that encourage the creation
of employee ownership. The United States before 2050 will abandon relying primarily
on taxation of income, and instead conform to most nations by relying on the
taxation of economic transactions, either with a value added tax, or with a
national sales tax. I will comment on what this means for employee ownership
legislation a bit later. Another important development, will be the changing
of the accounting treatment of stock options so that they are no longer as attractive
to major employers (as they are currently not reported as a current compensation
cost lowering earnings per share). Given that there will also be no income tax
to deduct the cost of the compensation, this form of employee ownership will
face a rocky future in the 21st Century.
Finally, in predicting big picture changes for the 21st Century that will impact
employee ownership legislation, I predict that the current trend towards relying
on individuals to save for their retirement will dissipate, and the pendulum
will swing back towards federal laws mandating that employers set aside some
of the business's cash flow for employees' retirement funds, either in a much
larger and grander Social Security type fund that invests in the private sector,
or in a new supplemental national pension fund.
So, in the 21st Century we will see a world where tax incentives through the
federal income tax for creating ESOPs, or any form of employee ownership are
irrelevant, because there is no income tax, or a very minor income tax.
Does no federal income tax mean the death of employee ownership? No I would
predict just the opposite for two reasons.
One, the idea of employee ownership, combining two powerful social realities—employee
and ownership—has gained acceptance in the last 25 years of the 20th Century
among business leaders, and many union leaders, as a good thing. Thus, as the
21st Century unfolds, the body politic is ready to have this general view of
employee ownership translated into political action evidenced by concrete policies
to encourage employees owning significant stakes in their companies.
Two, the track record of employee-owned companies over the past 25 years is
just "darn" good, no matter what the cynics in the bowels of the federal
government think. Sure, there have been failed ESOP companies in the last 25
years. Sure, some ESOP companies have flashed across the sky in a blaze, and
then burned out into oblivion after a few years. Sure, federal regulators have
brought legal action against some ESOP fiduciaries where they were helping themselves
and not employee owners. And, yes, many wonderful ESOP companies are bought
by new owners after 10 years or so, making one wonder if employee ownership
is a permanent condition when established through an ESOP.
But you know what, despite these examples, which ESOP and employee ownership
critics like to cite, the overwhelming majority of ESOP and employee-owned companies
have done well for employees, and in many instances where ownership and employee
empowerment are married, the results can be staggering, both in terms of financial
reward, and in terms of maximizing human potential.
So, couple the impressive track record of ESOP and employee owned companies,
which have led to a general acceptance that employee ownership is a good thing,
and I predict that in the 21st Century tax incentives for the creation of employee
ownership will be replaced, within 20 years of the demise of the current tax
system on income, with other incentives for employee ownership.
What kind of incentives? Perhaps preferences for employee-owned companies in
the awarding of contracts for government work. Perhaps preference in privatizing
certain functions now carried on by government employees to new employee-owned
companies. And, under a VAT, or sales tax system, perhaps special tax rebates
for employee-owned companies. One might see the Kelsonian policy of credit preferences
molded into some kind of policy in the future. It is hard to predict what kind
of preferences for creating employee ownership might develop; but I have faith
that these preferences will develop if the strong performance of employee-owned
companies continues into the 21st Century.
To summarize, those wanting laws and the current specifics of our ESOP world
to continue will perhaps be dismayed to learn that the 21st Century ESOP will
not depend on tax codes, and might not even be called an ESOP. But for those
who believe employee ownership is a wonderful way for the free enterprise system
to benefit as many citizens as possible to the fullest extent possible, the
21st Century should not disappoint.
J. Michael Keeling is President of the ESOP Association, the Washington-headquartered, national non-profit association of employee-owned companies and ESOP practitioners. He is equally at home in ESOP companies and on Capitol Hill.
Lessons
of Mondragon's Employee-Owned Network
Karen Thomas
Last November I joined a group of 15 people from the US and Canada for a one-week
study visit of an employee-owned business network in the Basque region of northern
Spain. The Mondragon Cooperative Corporation, or the MCC, is named after the
town of Mondragon where many of the 100-plus firms in the network are located.
The MCC has developed the concept of employee ownership as a regional economic
development strategy much more broadly than has been realized yet in the US.
In addition to owning their employing firms, MCC employee-members own a group
of associated cooperatives including a bank, three research institutes, a university,
a corporate training center, and various entities for strategic planning, auditing,
job retention, and management of their profit-pooling funds.
Growing from one small employee-owned business in 1956, today the complex includes
firms engaged in automotive components, domestic appliances, machine tools,
industrial components, engineering, construction, and retail distribution with
a workforce of 42,000 worldwide and over 5 billion euros in annual sales. MCC
employment accounts for 14% of the industrial employment in their province,
and 6% of the total employment.
Comparable to highly democratic ESOPs, MCC members each hold one member share
in the corporation they own, have direct authority for governance of their employing
firm on a one-person, one-vote basis, and elect representatives to a Cooperative
Congress that has final authority at the corporate level of the MCC on policies
governing all the member firms and their associated organizations.
Employment and wealth creation for the community as a whole is their primary
corporate mission. They are not successful because of their business drive or
their ideas about sharing ownership but because they link both ideas. The Mondragon
experience demonstrates that democratically governed businesses are high performance
businesses, that capitalism combined with community responsibility creates real
prosperity for a region, and that successful economic development is all about
grass-roots efforts that involve interlinked, locally based, research, education,
and financial partnerships.
Though Mondragon has served as an inspiration to me and the others in our study
group, we were all very skeptical whether the reality would match our ideal
vision. We knew that the MCC now invests in plants in low-wage countries, employs
increasing numbers of non-members (now 30%), has joint ventures with conventional
firms, sells non-voting stock to outside investors, and no longer supports local
cooperative start-ups. We knew that the cooperatives have democratic processes
for governance but use traditional methods to organize and manage their work.
The members I met struggle with the realities that business people face in our
global marketplace. Transforming their workplace culture is as important to
them as it is for employee-owners in Ohio.
We landed in Bilbao, the region's largest city. Situated on the Atlantic coast,
Bilbao reminded me of Cleveland—an industrial city with an aging steel
industry and a new tourist-magnet on its waterfront, the Guggenheim Museum.
We traveled inland by bus encountering heavy traffic along steep mountain roads
and hillsides of grazing sheep next to construction sites for high rise apartments.
Fifty years ago when the first cooperative was started here, poverty was widespread
in the aftermath of Spain's civil war. A recession in the 1980s and early 1990s
and the removal of protective tariffs in Spain resulted in the closing of many
local businesses. But a recent upswing in the economy in Spain and the rest
of the European Union has brought more jobs and immigration to the region. Unemployment
is at 15%; the lowest in 20 years.
In a valley surrounded by mountains lies the old/new town of Mondragon with
a population of around 30,000. A bronze dragon overlooks a sprawl of new development
along the valley. Remnants of medieval walls encircle a central business district
with busy shops and narrow cobblestone streets. Families walk outdoors together
to shop and visit in the early evening.
We walked too. On our first visit we climbed upwards from the MCC's engineering
school campus, past the headquarters of their jointly-owned insurance company,
past one of their research institutes, past a student cooperative that manufactures
educational equipment, past a new data processing center, past the headquarters
of their bank which is now the 38th largest banking institution in the world,
to reach their MCC corporate headquarters, a rather unassuming building.
How Mondragon
Works
Mountain bicycle racing is a popular sport in the area, and one of
the Mondragon firms makes top-of-the-line racing bicycles.
Much like the gears on a bicycle, the member firms in the Mondragon network
interlink for leverage to achieve greater heights of business success. A unique
and innovative blend of principles, practices, and structures are carefully
aligned for their mutual success.
"We balance capitalism and co-operativism," explained Mikel Lezamiz,
a staff member at the MCC executive education center. "We think about both
the economic and the community benefits in making our decisions."
Cooperative values of democratic decision-making, profit-sharing, and community
responsibility are combined with entrepreneurial practices in structuring the
business. This strategic philosophy, which is unusual in a corporation the size
of the MCC, is due to the influence of Don Jose Maria Arizmendiarrieta, a local
priest, who preached Catholic social doctrine and led the then-impoverished
citizens of the town to build an engineering school fifty years ago. When five
of the first graduates found few job opportunities, this priest helped them
borrow money and start a business making oil stoves. When they needed more capital
for expansion, he helped them to start a community-supported credit union. The
one small business multiplied into other related businesses at a rapid rate
during the 1960s. Arizmendiarrieta provided a model for visionary leadership
that is both community-minded and entrepreneurially-minded. He recognized the
shared values around which community members would collaborate.
Financial Rights
and Benefits
The financial benefits of workers' membership within the MCC network,
which include job security and profit-sharing, provide reciprocal benefits back
to the employing firms. Members' share purchase and profit-sharing are reinvested
for continual business growth; employee turnover is minimal.
Financial benefits also accrue directly to the broader community. Cooperative
businesses in Spain gain a tax advantage for sharing profits with their members
and community. While Spain has a 32.2% corporate tax rate, the tax rate for
a cooperative business is only 20% if the coop contributes 10% of profits to
philanthropic purposes. By member firms' agreement, the year-end profits of
each MCC business is distributed 10% to community projects; 45% to members;
and 45% is retained in the firm for business needs.
Members' rights extend beyond job security and annual profit-sharing to include
a direct voice in governance within their employing firm. Each member has a
vote on major policies of pay, financing, MCC membership, and pooling with other
firms. Members have representation in governance and management of their bank,
research institutes, the university, and other service organizations.
The MCC has a no-layoff policy and transfers workers based on demand. Cutbacks
are achieved through reassignment to other coops or the nonreplacement of retirees.
Each worker-member has an internal capital account in the cooperative which
holds annual profit-sharing, the 75% recoverable portion of the member share,
and accumulated interest earnings. An unrecoverable twenty-five percent of each
member's share purchase price is placed in the cooperative's reserve fund. The
structure of internal capital accounts, which was Mondragon's innovation, has
been widely adopted and codified elsewhere including the State of Ohio's cooperative
legislation.
Democratic Governance
and Control
All the members of each cooperative meet yearly as a General Assembly,
the body with the highest authority in each firm. This assembly elects the board
and votes on company-wide policies. Board candidates are nominated 1/3 by open
nomination, 1/3 by worker representatives, and 1/3 by top managers. At Mondragon
University the board is nominated 1/3 by students, 1/3 by faculty, and 1/3 by
collaborating institution. The bank board must have a majority of directors
from among the member firms that own the bank but the General Assembly is split
50/50 between bank employees and representatives of member firms. In retail
stores, the customers can be members too and must hold the majority of seats
on each store council.
Functioning much like unions, "social councils" within each firm have
elected representatives who decide on wages, health and safety, work design,
technology, and operating policies. But unlike most unions, the social councils
in these close-knit communities have historically not challenged management.
Pooling Resources
to Build a Cooperative Economic Sector
Synergy, through the sharing of financing, research, and educational
resources, are key elements to support the growth of each small business. Firms
with related products, customers, and markets pool between 15-40% of their profits
for development and new business promotion. Another intercooperative investment
pool, funded by each firm's annual contribution of 10% of profits, provides
funding for projects which promote job creation, internationalization, profitability,
worker involvement, or customer satisfaction. Yet another intercooperative fund
pools 20% of annual profits from member firms in a reserve fund which supports
troubled firms and protects all firms against insolvency.
With community support in 1959 a community credit union (the Caja Laboral) was
formed, which continues to involve thousands of local people, and is now rated
among the 100 most efficient financial institutions in the world. In the early
years it held the member businesses together in its orbit under a contract of
association that standardized the structures for intercooperation. The bank
provided patient venture capital for the rapid expansion of many small firms
throughout the 1960s and also provided audit and advisory services to enforce
sound business practices. Now the bank must meet the regulatory standards of
the banking industry in Europe, so it can no longer serve as a friendly financier
and technical consultant.
Research and education for the continual application of new technologies and
ideas is supported through several institutions owned by member firms. The engineering
school is now part of Mondragon University. Each member firm contributes 5%
of annual profits into an intercooperative fund which subsidizes collaborative
research and education projects.
The old adage that "knowledge is power" is conveyed by the MCC's Otalora
Corporate Training Center in a renovated, 14th century, mountain-top fortress.
The battlements have been replaced with conference rooms and computer labs.
The staff of Otalora, who hosted our visit, offer executive management education
through MBA programs and seminars which combine business content with cooperative
values.
The MCC cooperatives have created thousands of jobs, anchored capital in the
region, and created businesses that specialize in housing development, urban
planning, and renovation. Their 10% philanthropic allocation supports hospitals,
schools, and Basque culture.
The success of this network of affiliated employee-owned firms is due to the
factors described above but also to what might be termed the "hothouse"
economy in the region during its formative years. These optimal economic conditions
were provided by Spain's protective tariffs and major efforts of Spain's government
toward a national economic recovery during the 1950s and 1960s. But the marketplace
has changed.
Local Economic Development
in a Global Economy
Since the late 1980s many MCC member firms have been in a "compete
or close" situation. They directly compete with the world's top corporations
to survive. Instead of developing new, local businesses they are trying to strengthen
the businesses they already own and expand into broader markets.
Three internal strategies support this outward focus. The network has become
a holding company; firms are grouped within product sector divisions; and education
for cultural change toward greater teamwork among managers and workers is encouraged.
Inverted Conglomeration
The new legal structure of firms within the MCC corporate structure
is called an "inverted conglomerate" because each individual firm
retains its legal autonomy. Designed for greater market access, firms merge
strategic planning, profit-sharing, and technology investments at division levels.
The members of each firm, through their General Assembly, can vote to join or
leave the MCC at will.
Unlike most large corporations, authority at the top is limited. The CEO and
senior management have influence but the power to make decisions resides within
the individual firms. Though senior management must implement corporate-wide
strategies they have to continuously negotiate with member firms in order to
achieve them.
A 650-member Cooperative Congress, representing each member firm, holds member
firms together around common policies. Each of the three divisions has its own
Governing Council and together they elect the corporate-level board which appoints
the CEO and oversees the MCC.
Strategies for Growth
Individual firms and sub-groups now partner with firms outside the
Basque region throughout Spain, Europe, and elsewhere. We learned about this
expansion strategy at the neighborhood Eroski Hypermarket, one of the flagship
stores of the MCC's Distribution Division. The retail division is the profit
leader among MCC firms accounting for 55% of total sales from their 1,000 stores,
500 supermarkets, a distribution franchising partnership with 2,000 corner grocery
stores, gas stations, and numerous other retail services throughout Spain. The
Eroski group plans to move into France and Portugal and open a total of 500
new stores in the next five years. Today the MCC is the largest Spanish retailer
in Spain.
The Eroski retail cooperative was originally developed to sell local consumer
goods on a local scale. We saw refrigerators made by Fagor Electrodomesticos
lining the aisles in the store's domestic appliance department; another store
department sells furniture made by other local member firms.
Eroski's phenomenal expansion is the focus for concerns about whether the cooperatives
are failing to maintain a balance of co-operativism and capitalism. The cooperative
ideal is to stay small and local. But, the big fish eat the little ones in the
European grocery industry.
While purchasing is centralized for the Eroski group, the operations in each
Eroski store are decentralized. Customers may join as members of Eroski; and
only elected customer-members at each store can preside over the store's council
meetings. Members get daily store performance results. Part-time store employees
join for a lower member share price and non-member temporary workers earn 25%
of the profit-sharing bonus earned by members.
No new employee-owned member businesses, large or small, have been started within
the Mondragon network since the 1970s. Instead, the businesses in which they
have already invested sizable resources over the past fifty years are being
strengthened internally and externally.
We visited one of the local Fagor Electrodomesticos plants to learn more about
this strategy. Fagor was the largest of all the firms in the network (until
the retail expansion), has had the greatest technology investment of all the
firms, and has prevailed through the greatest sacrifices of its membership.
High hopes have enabled it to grow and survive but times have changed. Highly
profitable during Spain's protected economic era, now it faces fierce competition.
Consolidation within Europe's appliances sector has left six domestic appliance
manufacturers; Fagor is the smallest.
We toured the refrigerator plant, with HR regional director, Jesus Labayen,
where 1,000 people work in three shifts. He explained that the older workers
in this plant have significantly lower internal capital account balances (on
average about one-eighth) than the balances of newer workers. Big losses during
the early 1990's recession emptied the older members' accounts. These members
took out loans and used their own money to save the firm.
Fagor produces three major brands, and bought the rights to produce White Westinghouse
appliances in order to expand into the European marketplace. They have also
purchased a plant in Poland. Here in the local plant, long assembly lines have
been replaced by short assembly lines manned by multi-skilled work teams. Above
the workstations are digital signboards of the production defects and performance
measures per shift. This plant delivers on orders in 48 hours.
The economic crises have opened members' thinking about what it means to thrive
in global markets and what it means to be employee-owned. People are very aware
that total quality depends on their ability to work together. Firms are starting
to engage their members in dialogue about ways to transform organization practices
through greater cooperation.
Irizar, an assembler of custom tour buses, responded to the crisis by introducing
cooperative workplace practices. Irizar was nearly bankrupt in the early 1990s
from dwindling demand for its products. A new CEO, who was brought in to reengineer
operations, organized meetings with the members and sought their input on the
firm's future. The workers decided that they wanted to compete at the highest
level of technology for luxury coaches in the European market and agreed to
overhaul their entire work process to integrate continuous quality improvement
processes with cooperative values. They eliminated supervisors and created five-person
self-managed work teams that negotiate with suppliers, plan their work schedule,
and take full responsibility for quality. They reduced production time by 50%
and now are the #2 luxury coach manufacturer in Europe but #1 in profitability.
They export to 35 countries. While most reengineering efforts involve cutting
jobs, they have doubled their local workforce.
They also engage in technology transfer, selling the technologies and expertise
to build their older model coaches through joint ventures in developing countries
where there is a growing market. They have built plants in Morocco, China, and
Brazil. We visited the day before their all-employee fiesta to celebrate their
plant opening in Mexico to enter the US market.
Are Mondragon's Cooperative
Ideas Transferable to Ohio?
The Mondragon approach demonstrates an economic development model
based on the support of small business start-ups through the creation of a small
business network which essentially serves as a small business incubator. Its
effectiveness stems from a number of innovations.
One innovation is employee ownership. Firms avoid the costs associated with
providing high returns to outside investors by employee ownership. Employee
ownership means that the employees have a stake in the business and reinvest
their ownership share and profit-sharing to finance its growth. By itself, employee
ownership is often risky, but the risk can be shared broadly among all the employee-investors
within all the businesses in the network.
The Mondragon model suggests that the optimal size of an employee-owned firm
is small to mid-sized but that the optimal size of an employee-owned business
network is large. While most Americans have not been oriented toward forming
small business networks, a growing number of U.S. firms are involved in group
purchasing cooperatives which achieve economies of scale through pooling resources.
The floral industry's FTD cooperative is one example.
A credit union or bank, owned jointly by all the member firms, is another innovation.
In Mondragon's case it enabled community members to provide patient venture
capital for local development and generate reciprocal support for the development
of hospitals and schools. We see the opposite dynamic in many U.S. communities
where small business development programs rely mainly on federal funds while
bank consolidation has made the hometown bank an endangered species.
Local credit unions and community banks can provide financial support for local
small businesses through: (1) exploring ways to create community investment
pools that are owned and governed by a broad spectrum of community stakeholders;
(2) encouraging the creation of patient venture capital investors through tax
savings for those making a corresponding philanthropic investment to local community
development funds.
The Mondragon retailing system, which integrates producers, employees, and customers
as members, business partners, and co-investors, is another innovation. Local
businesses can bring more of their stakeholders, including employees, customers,
and local suppliers into the business. Businesses which receive local tax abatements
and other government assistance could be required to share ownership rewards
with the employees and the community.
Investment in community-based, jointly-owned research and education institutions
is another innovation which supports startups and existing businesses toward
higher performance. Local technical schools could partner for the philanthropic
support of local businesses in providing business incubator services for students.
Economic development efforts could focus on managerial and employee education.
One last and all-encompassing innovation is the "open business organization."
The Mondragon model decouples governance and management within business organizations
through (1) broad-based ownership encompassing many stake-holders, and (2) the
development of open and independent boards. The MCC's inverted conglomerate
formalizes the spirit of employee empowerment. The MCC's flexibility and economic
success attest to the virtues of democracy in economic life.